Chapter Summary

In over two hundred years, economists have gradually developed two major approaches to explaining and interpreting the growth of real gross domestic product per capita and the coincident improvement in standards of living in many countries. By way of summary, let's review the troops and say a little about the kind of government policy each would most likely favor.

Virtuous Circle Theories

These theories see increasing labor productivity as "endogenous," that is, a result of economic events. Smith understood increasing division of labor as the source of increased productivity, while twentieth-century virtuous circle theorists have seen in addition several other sources, all interconnected and to some extent overlapping with one another and with the division of labor:

• economies of scale
• learning by doing
• endogenous innovations

Virtuous circle theorists would all agree with Smith that the government ought not do anything to cause the cycle to be broken, but some of the twentieth-century virtuous circle theorists might call on the government to remove barriers that could arise in the private sector.

Resource Theories

The Malthusian Theory

Malthusian theories see land (and, in the twentieth century, other natural resources) as the ultimate limits to growth. Since growth can only put off the inevitable, Malthus and his followers might call on government to take actions which would slow down growth. For example, Malthus wanted to protect British agriculture from competition from imported grain, which favored industrialization but harmed British agriculture. Some twentieth century Malthusians, who do not share Malthus' belief that contraception is sinful and vicious, would like to see government policies that favor contraception.

Capital-limit theories

These theories see capital, not land, as the limit to growth. Since capital can be increased by saving and investment, they favor government policies that encourage rather than penalizing saving and accumulation of wealth. Some would have the government go even further and contribute to capital accumulation by raising taxes and running a surplus, making the surplus available to support investment. A few, following Roy Harrod, might call for government action to assure a balance of investment and labor force growth. What sort of government action? We will spend several chapters on that question when we take up Keynesian ideas.

The Neoclassical Theory

The Neoclassical theory is a capital-based resource theory with a special twist: it sees economic growth as a moving balance between diminishing returns to the growing capital resource, on the one hand, and the growth of knowledge of technology, on the other. But since it sees innovations not as endogenous but as the result of events outside the economy -- the progress of knowledge -- the neoclassical theory has almost the same policy prescriptions as the other capital-based theories. Almost, but not quite: for the neoclassical theorist, saving should be encouraged only up to a point. After all, capital is subject to diminishing returns.

Even after two hundred years, there are still some disagreements to be ironed out! But whichever theory of growth we think is most promising, they all share a broad scale in terms of time. No doubt that is one reason why we are still so much in doubt: for theories such as these, a couple of centuries' experience still isn't much. But many important macroeconomic problems come (and sometimes go) much faster, and that is a reason why modern macroeconomics has generally focused on a shorter time-frame. Accordingly, we will next look at some of those problems and our experience of them in the twentieth century.

Next Chapter: Macroeconomic Problems

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